By Rae Wee and Alun John
SINGAPORE/LONDON (Reuters) - The dollar started the week on the back foot, hitting a seven-month low against a basket of major peers in Asian trade before steadying, with the yen in particular focus due to traders' bets the Bank of Japan will tweak its yield control policy further.
The euro hit a fresh nine-month top of $1.0874 in early trade before retreating to last stand 0.16% lower at $1.0816, while the Australian dollar breached the key $0.7000 level for the first time since August, before dipping back to $0.6962.
Thanks also to early strength from sterling and the Japanese yen, the dollar index, which tracks the greenback against a basket of currencies, slumped to a seven-month trough of 101.77, extending its selloff from last week after data showed that U.S consumer prices fell for the first time in more than 2-1/2 years in December.
With decades-high inflation in the world's largest economy showing signs of cooling, investors are now growing increasingly confident that the Fed is nearing the end of its rate-hike cycle, and that rates will not go as high as previously feared.
The Fed's aggressive rate increases were a main driver of the dollar index's 8% surge last year, before signs that inflation was peaking brought it back down.
The dollar has largely traded steady against most currencies since last week's data.
"It's too soon to imagine a significant dollar downtrend, we've had some dollar repricing certainly, but for broad-based dollar weakness you'll need to really see Fed expectations roll over materially and the Fed potentially cutting rates at some point, and we are not at this point," said Samy Chaar, chief economist at Lombard Odier.
Markets are now pricing in a 91% chance of a 25-basis-point increase when the Fed announces its policy decision in February, with a 9% chance of a 50-bp hike.
The dollar steadied in European trading, regaining ground against the pound which was last down 0.3% at $1.2195.
MARKETS CHALLENGE BOJ
A particular focus for currency markets this week is the Japanese yen, due to speculation that the Bank of Japan will make further tweaks to, or fully abandon, its yield control policy at a meeting scheduled to conclude Wednesday.
The dollar slipped to a more than seven-month low on the yen in early trading, before recovering and was last at 128.4 yen, up 0.4%.
"I think the whole world will be focused on Wednesday ... and probably the week in G10 (currencies) will be defined by what happens to the yen and yen crosses, out of that," said Ray Attrill, head of FX strategy at National Australia Bank (NAB).
"I don't think (the BOJ) has the luxury of time to say that they're going to assess and wait until Q2 or Kuroda to see out his term without making any further changes."
BOJ Governor Haruhiko Kuroda will step down in April.
Investors have been pressing for the BOJ to shift away from its ultra-easy monetary policy, which caused the yield on Japan's benchmark 10-year government bonds to breach the central bank's new ceiling for two sessions.
U.S. markets are closed on Monday for a holiday, making for thin trading.
(Reporting by Rae Wee in Singapore and Alun John in London; Editing by Emelia Sithole-Matarise, Kirsten Donovan)